Financial Reporting

Statement of Federal Financial Accounting Standards No. 3, Accounting for Inventory and Related Property, specifies different categories of tangible property for financial reporting and disclosure. Two of the asset categories applicable to the Defense Department (DOD) under the standard are "inventory" and "operating materials and supplies." This report reviews DOD's fiscal year 1996 financial statements and determines whether its approach to reporting inventory and operating materials and supplies meets No. 3's requirements--for individual military service financial statements as well as those at the consolidated DOD-wide level. GAO discusses how the accounting standards are to be applied to improve the reporting of inventory and operating materials and supplies in DOD's financial statements.

GAO noted that: (1) DOD did not fully comply with SFFAS No. 3 in FY 1996; (2) its consolidated and component financial statements misclassified operating materials and supplies and some equipment as inventory and did not include all operating materials and supplies; (3) for FY 1996, the Army, Navy, and Air Force general fund financial statements collectively reported $115.6 billion of inventory; (4) the Army and Air Force did not report any amounts for operating materials and supplies and the Navy reported only $27,000; (5) one reason for these errors is that DOD's "Guidance on Form and Content of Financial Statements for FY 1996 Financial Activity" and its accounting policy misinterpreted and were not consistent with the accounting standard; (6) as a result, DOD's FY 1996 financial statements overstated inventory, understated operating materials and supplies, and overstated expenses; (7) about $113.7 billion out of the $115.6 billion reported as inventory by the general funds consisted of munitions and equipment that met the SFFAS No. 3 definition of inventory and should have been classified as operating materials and supplies or plant, property, and equipment; (8) at the same time, other items warehoused by service activities, such as repair parts and consumables, that met the SFFAS No. 3 definition of operating materials and supplies were not reported at all; (9) GAO, the DOD Inspector General, and the military service auditors have reported that the military services have warehoused billions of dollars of items at bases and on ships that meet the SFFAS No. 3 definition of operating materials and supplies; (10) however, these items were not considered as capitalized assets as required, but were instead expensed on the financial statements when purchased; (11) the $113.7 billion of misclassified assets represents 9 percent of total assets reported and therefore was material to DOD's FY 1996 financial statements; (12) continued material misclassification and underreporting will negatively affect the reliability and usefulness of the military services' and DOD's financial statements and also the auditors' opinions on those statements; and (13) DOD's guidance and accounting policies must comply with accounting standards so that inventory and operating materials and supplies are properly classified and reported in its future financial statements.

Recommendations

Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.

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